Thursday, 17 May 2018

Surprises are over-rated

It’s generally best, in fiscal and monetary policy, to make your plans clear and stick to them: Finance Ministers and central bank governors are better off leaving the rabbits in the hats. So the first good thing to say is that this government made its plans reasonably clear early on with its “100 Days” initiatives last year and in the pre-Budget positioning over the past few weeks, and the Budget itself was mercifully rabbit-free.

Everyone expected this to be a Budget that would deliver a large boost to spending on core government services like health and education, and it was. Of the extra $11.4 billion in operating expenditure that the government plans to spend over the five years to 2021-22, for example, $6.5 billion goes under the heading of “rebuilding critical public services”: health gets $3.25 billion of it, and education $1.6 billion.

Everyone also expected the Budget to stick to a “fiscally responsible” script, and it did. There will, for example, be fiscal surpluses every year from here,  building up to a forecast $7.3 billion surplus in the year to June ‘22, which would be a reasonably sizeable 2% of so of total GDP. The likelihood of the New Zealand political process actually leaving $7.3 billion unspent on the table is extremely low, but at least for now the intention is there to run ever larger surpluses and get net public debt down to below 20% of GDP.

The Budget’s also one of the big forecasting set pieces, and once again there were no huge surprises in the expected economic outlook – ongoing growth in the next few years at about 3% a year, enough to get unemployment down to 4.1% by the middle of 2020. There are two big uncertainties (apart from the ever present risk of international instabilities). One is whether housebuilding has the capacity to grow at the rate Treasury expects: not much in the coming year to June ‘19 (+1.4%) but quite substantially in the two years after that (+5.0% and +5.5%). That’s a big ask for a sector widely suspected of capacity constraints. The other is net immigration: the Treasury thinks it will gradually drop off to a net gain of about 25,000 people a year, but the reality is, it’s anyone’s guess, as you can see from these different forecasts (a graph included in the Budget Economic and Fiscal Update).

A key aspect of the Budget is whether fiscal policy boosts or brakes the overall economy. Here’s the answer, acknowledging that the calculations are down the iffier end of the spectrum of economic analyses. Fiscal policy gives the economy a decent boost of about 1% of GDP in the current year to June ‘18, and much the same again in the year to June ‘19, before the brakes go on in later years. Again, I’ll be surprised if the political process actually allows those brakes to be applied, but again the effort is currently there to keep fiscal policy on prudent lines.

And policy – particularly in small open economies on earthquake plates – needs to keep a reasonably conservative grip to leave us lots of room to cope with external or domestic shocks. We can’t flag away a “rainy day” approach, particularly as our forecast fiscal surpluses are reliant on us continuing to benefit from high world prices for the things we sell. Here’s a somewhat worrying picture: it shows our forecast fiscal surplus track, adjusted for the cyclical state of the economy, compared with what the picture would be if our terms of trade were at their 30-year average, and not well above it. Answer: if the world became very difficult for the likes of our dairy farmers, there would be no surpluses, not now, not in future.

All that said, and accepting it’s a balancing act, you’d wonder if the Budget wasn’t almost too conservative. These are, for example, exceptionally good times to be be spending even more again on infrastructure: the accumulated shortfall is huge, and financing costs are still very low, even if we’ve somewhat missed the boat on raising money at the exceptionally low financing costs of 2016 and 2017. I’m not sure I’d agree with the claim in the Budget speech that new transport spending in Auckland, large as it is, will in fact be enough to “free up our biggest city”.

Whether it got the balance right between social policy and economic development is also debatable. The Budget will be putting a rather smaller $2.8 billion of operating spending into “Promoting economic development and supporting the regions”, compared to the $6.5 billion on public services. And there’s a lot under that label that is a stretch to call a contribution to economic development, including the big $1.1 billion expansion to our “international presence” and the Provincial Growth Fund boondoggle.

To be fair, there is one productivity initiative which could be significant. The Budget expects the government to spend over $1 billion if businesses take up the R&D tax credit to the degree it expects (12.5 cents back for every dollar spent, for companies spending at least $100K a year on R&D).

But has enough overall been done to facilitate a decent lift in our productive potential? If you take the view that we need a step lift to our game, the forecasts don’t suggest it’s in our near-term cards. The IMF, for example, thinks word trade will grow by 5.1% this year and by 4.7% in 2019: the Budget forecasts don’t see our exports of goods and services keeping up with world trade growth in general.

One Budget, obviously,  isn’t going to transform our low productivity overnight, and even a  succession of Budgets strongly friendly to facilitating productivity may only go part of the way. But this time next year I think I’d like to see rather more focus on closing the gap with the kinds of income the higher-performing economies in the OECD are capable of generating for their citizens.

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